Question

Several years ago Samuel Enterprises sold a $1,000 par value, 7% semi annual coupon bond that now has 20 years to maturity. The bond is noncallable and currently sells for $975. The company’s tax rate is 25%. What is Samuel Enterprises' after-tax cost of debt?

	a.	4.33%
	b.	6.22%
	c.	7.24%
	d.	5.43%
	e.	8.29%

Answer 1

Answer: The correct answer is d i.e. 5.43%

Face Value = $1,000
Current Price = $975

Annual Coupon Rate = 7%
Semiannual Coupon Rate = 3.50%
Semiannual Coupon = 3.50%*$1,000 = $35

Time to Maturity = 20 years
Semiannual Period to Maturity = 40

Let semiannual YTM be i%

$975 = $35 * PVIFA(i%, 40) + $1,000 * PVIF(i%, 40)

Using financial calculator:
N = 40
PV = -975
PMT = 35
FV = 1000

I = 3.62%

Semiannual YTM = 3.62%
Annual YTM = 2 * 3.62%
Annual YTM = 7.24%

Before-tax Cost of Debt = 7.24%
After-tax Cost of Debt = 7.24% * (1 - 0.25)
After-tax Cost of Debt = 5.43%